Month: May 2017

As discussed first thing this morning, the fate of Canada’s largest alternative mortgage lender, Home Capital Group, appears to have been decided over the weekend, when in the span of just one week, over 70% of the company’s deposit base had been withdrawn, effectively mothballing the business, leaving just a sale or liquidation as the two possible outcomes even as a $2 billion emergency line of credit keeps the company afloat, at least until HCG’s $12.8 billion in GICS mature some time over the next 30 to 60 days.

Predictably, the news of the ongoing bank run once again spooked shareholders, who sent its stock sliding by 10%, and wiping out two-thirds of the company’s market cap in under 2 weeks.

A bigger red flag emerged when concerns about possible contagion appeared to have been justified Canada’s Equitable Group, another alternative mortgage lender, said Monday it had started seeing “an elevated but manageable” decrease in deposit balances, traditionally a polite way by management to admit a bank jog is taking place. The company said that customers had withdrawn an average C$75 million each day between Wednesday and Friday, and while the withdrawals so far are modest, and represented 2.4% of the total deposit base, the recent HCG case study showed how quickly such a bank run could escalate. And while liquid assets remained at roughly C$1 billion after the outflows, the company also announced that it had taken out its own C$2 billion credit line with a group of Canadian banks, just in case the bank run was only getting started.

Having taken preemptive action, Equitable’s loans terms were more favorable than Home Capital’s, which as reported last week is paying an effective rate of 22.5% on the first half of the C$2 billion credit line that it tapped Monday from the Healthcare of Ontario Pension Plan.

According to Bloomberg, Equitable is paying a far more modest 1.25% interest rate on the drawn portion, and a 0.75% commitment fee and a 0.5% standby charge.

Trying to mitigate concerns, Andrew Moor, CEO of Equitable said that “the issues affecting the well-known trust company in Toronto are their issues alone, and it’s unfortunate the banking industry has been dragged into it.” He spoke on a call to discuss earnings, which were published almost two weeks earlier than planned due to the Home Capital selloff.

To be sure, looking at historical credit losses, Equitable would be deemed quite safe, barely ever having seen any, which in retrospect may be troubling: another company which is in the same boat is none other than Home Capital Group.

Following news of the Equitable loan, a relief rally sent shares of the lender soaring by 26% to C$46 in Toronto, helping recoup some of the 41% drop from last week. Other Canadian bank stocks that had fallen last week also recovered Monday. First National Financial Corp., a mortgage lender, jumped 2 percent. Bloomberg notes.

So while Canada’s nervous investors, not to mention its regulators, exhaled a breath of relief today hoping that things are back to normal even as they continue to keep a close watch on Equitable and other alt-lenders to see if the panic has subsided, attention turned to Home Capital’s bonds. Bloomberg reports that Home Capital’s bonds maturing in December next year were trading little changed at 90.6 cents on the dollar on Monday, according to Bloomberg data, yielding about 10 percent, compared with less than 3 percent on April 19. Home Capital also has C$325 million in 2.35 percent bonds maturing on May 24.

“Things are perhaps all right from the bondholder’s perspective, but not certain and the bonds reflect that,” said Mark Carpani, a portfolio manager at Ridgewood Capital Asset Management, with C$1.1 billion in assets. He said he doesn’t hold any Home Capital bonds and declined to comment at what level he’d consider buying them.

While an optimistic outlook may be warranted, the biggest risk as explained this morning, remains with HCG’s C$12.8 billion in GIC deposits which are essential to fund its mortgage business, and which represents 1 percent of the Canadian mortgage market. Withdrawals could accelerate as these short-term deposits mature.

What is the worst case scenario?  Declining deposits could lead to a windup of the company, which would be monitored by the federal bank regulator, the Office of the Superintendent of Financial Institutions, according to Bloomberg. The lender said Thursday it has hired BMO Capital Markets and RBC Capital Markets to conduct a review of strategic options, signaling that a sale may be on the table.

“OSFI maintains ongoing relationships with the financial institutions it supervises,” Annik Faucher, an OSFI spokeswoman, said by email. “While we are prevented by law from discussing the affairs of the individual financial institutions we regulate, or our ongoing supervisory work, I can confirm that OSFI is continuing to monitor the situation closely.”

Concern about the viability of HCG has extended to the Canadian government itself, with Finance Minister Bill Morneau saying in a statement that he has been monitoring the Home Capital situation “very closely.” 

“I was pleased to see Home Capital’s funding issues resolved by market participants,’’ Morneau was quoted as saying. “What I’ve seen over the last few days is proof the system is working as it should, where institutions facing challenges find market-based solutions.”

Actually, the funding issues are anything but resolved, as the next 30-60 days may reveal.

However, it is perhaps the hint of a government backstop that prompted Home Capital’s biggest investor to announce he is sticking with the company, adding to its position. Toronto-based Turtle Creek Asset Management Inc., which owned 14% of Home Capital as of the end of February, praised the lender for its low loss rate and underwriting practices.

“To be clear, we have not sold shares; indeed, the opposite is the case,” according to an investor letter, signed by Chief Executive Officer Andrew Brenton, managing partner Jeffrey Cole, and managing partner Jeffrey Hebel. “We are obviously not happy with recent developments at Home Capital, but we remain focused on long-term value creation for you, our fellow investors.”

Well, as long as the “fellow investors” are fine with the short-term value destruction, all should be well. Ironically, for investors like Brenton, the “best” possible outcome would be the worst one, or runaway contagion and bank runs, which would force the government to step in and do what the US government did nearly a decade ago: bail out not only Canada’s housing market, but also its insolvent mortgage lenders, as well as any other banks and financial institutions that would be slammed by the bursting of Canada’s housing bubble.

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In case you were starting to lose your fearmongered concerns, The US State Department has come to the rescue with a travel alert for visitors to Europe warning of "the continued threat of terrorist attacks."

Travel Alert – Europe

 

May 1, 2017

 

The Department of State alerts U.S. citizens to the continued threat of terrorist attacks throughout Europe. This Travel Alert expires on September 1, 2017.

 

Recent, widely-reported incidents in France, Russia, Sweden, and the United Kingdom demonstrate that the Islamic State of Iraq and ash-Sham (ISIS or Da'esh), al-Qa'ida, and their affiliates have the ability to plan and execute terrorist attacks in Europe. While local governments continue counterterrorism operations, the Department nevertheless remains concerned about the potential for future terrorist attacks. \

 

U.S. citizens should always be alert to the possibility that terrorist sympathizers or self-radicalized extremists may conduct attacks with little or no warning.

 

Extremists continue to focus on tourist locations, transportation hubs, markets/shopping malls, and local government facilities as viable targets. In addition, hotels, clubs, restaurants, places of worship, parks, high-profile events, educational institutions, airports, and other soft targets remain priority locations for possible attacks. U.S. citizens should exercise additional vigilance in these and and other soft targets remain priority locations for possible attacks. U.S. citizens should exercise additional vigilance in these and similar locations, in particular during the upcoming summer travel season when large crowds may be common.

 

Terrorists persist in employing a variety of tactics, including firearms, explosives, using vehicles as ramming devices, and sharp-edged weapons that are difficult to detect prior to an attack.

 

If you are traveling between countries in Europe, please check the website of the U.S. embassy or consulate in your destination city for any recent security messages. Review security information from local officials, who are responsible for the safety and security of all visitors to their host country. U.S. citizens should also:

• Follow the instructions of local authorities. Monitor media and local information sources and factor updated information into personal travel plans and activities.
• Be prepared for additional security screening and unexpected disruptions.
• Stay in touch with your family members and ensure they know how to reach you in the event of an emergency.
• Have an emergency plan of action ready.
• Register in our Smart Traveler Enrollment Program (STEP).

 

We continue to work closely with our European partners and allies on the threat from international terrorism. Information is routinely shared between the United States and our key partners to disrupt terrorist plotting, identify and take action against potential operatives, and strengthen our defenses against potential threats.

This follows on from a general alert issued in March.

Afraid? You should be!

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Remember this…

 

Volume was dismal as most of the world celebrated May Day…Lowest volume of 2017 (and 40% below 2016's May Day volume)

 

The meltup in the biggest tech stocks continues, driving Nasdaq above 6,100 to record highs as The Dow sinks…ugly close for Dow and S&P… Dow closed -26pts (AAPL created +23pts today)

 

Just remember, it's different this time…

 

It's fun-durr-mentals…

 

Oh and AAPL earnings will help, right?

 

Since Trump spoke to Congress, The Nasdaq is the only major US index in the green as it has melted up in recent days…

 

And what sent Nasdaq soaring to 6,100 today? Simple – the death of risk…

 

As VIX crashed to its lowest intraday since Feb 2007…

 

Banks were briefly battered by Trump's comments on breaking them up, but dip-buyers scrambled quickly…though failed to hold into the close

 

Treasury yields were all higher on the day, despite Friday's terrible GDP data and today's dismal spending and PMI/ISM data… (and steepened notably)

 

30Y Yields rallied back to 3.00% by the close…

 

Oh – and as a reminder of just how bad it is…this morning's data, it has collapsed to the lowest level since Oct 2016.

 

The USD Index ended the day unchanged with AUD strength offsetting JPY and GDP weakness

 

WTI and RBOB tumbled further today…

 

Gold was hammered shortly after the London Fix (which did not occur because London is closed today)…

 

Gold broke below its 200DMA but perhaps more notable is Gold's outperformance of silver to unwind all loses since Brexit…

 

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Authored by Charles Hugh-Smith via OfTwoMinds blog,

Everyone wants an abundance of "good paying" jobs, but employers can only afford to pay employees if the work being done is profitable.

What's abundant and what's scarce? The question matters because as economist Michael Spence (among others) has noted, value and profits flow to what's scarce. What's in over-supply has little to no scarcity value and hence little to no profitability.

What's abundant is unprofitable work, commoditized goods and services, and conventional labor and capital (which is why wages are declining and yields on capital are near-zero).

What's scarce is profitable work, highly profitable niches that are immune to commoditization/ automation, and meaningful work.

Everyone wants an abundance of "good paying" jobs, but employers can only afford to pay employees if the work being done is profitable. Paying people to do unprofitable work is a one-way street to bankruptcy.

Those who want the government to fund "good paying" jobs forget that government tax revenues depend on profitable enterprises and the private-sector wages they pay.

(Borrowing from our grandkids to pay public-sector wages today is immoral and financially unsustainable.)

If we look at urban slums and impoverished rural communities, we find the problem isn't a lack of work that needs to be done–it's a lack of paid work and a lack of profitable work.

Businesses have pushed unprofitable work onto the customer. Paying people to pump customers' gas is not profitable (if it was, some corporation would be doing it). Rather than lose money by paying employees to pump gas, the industry shifted that unprofitable labor onto customers.

A great amount of useful work is not profitable and can never be profitable. We need to differentiate useful work from profitable work. One example that illustrates the difference is building and maintaining bikeways to serve commercial areas. (By this I mean bikeways not devoted to leisurely rides through parkways but bikeways that one can use to reach grocery stores, banks, post offices, cafes, childcare centers, etc.)

The work of building and maintaining safe bikeways is clearly useful. Safe bikeways have multiple benefits for commerce, communities, the environment and for individuals: safe commuter bikeways cut traffic congestion, improve the health of the bicyclists, lower healthcare costs, boost small businesses along the bikeways and reduce air pollution.

Safe bikeways (i.e. those which are dedicated to bikes so riders aren't sharing the road with semi-trucks and autos wandering over the pavement while the driver is texting) are win-win-win, yet they can never be profitable unless bicyclists are charged a toll, which defeats the entire purpose of the bikeway.

Impoverished areas are impoverished because there are few highly profitable scarcities to fill and few people with the surplus income to pay for profitable services. Taking money from one community to fund make-work jobs in another community (the essence of government redistribution schemes) deprives one community of income while providing a temporary injection of income in the other community–income that is controlled by a government that is itself controlled by lobbyists and privileged elites.

Redistribution schemes act as bread and circuses to suppress social disorder, but they don't address local scarcities in a sustainable way or foster the expansion of long-term solutions to a lack of work.

There are two fundamental solutions to a lack of profitable work. One is to pay people to do useful work that is not profitable and do so with a labor-backed crypto-currency that isn't borrowed or taken from some other community, and the second is to nurture community-economy entrepreneurship that works within decentralized networks and groups rather than through central states and global corporations.

I explain how these solutions work in my book A Radically Beneficial World: Automation, Technology and Creating Jobs for All.

Slums that get Universal Basic Income transfers from the government remain slums. All the work that needs to be done isn't being paid,soit doesn't get done.

Communities that rely on global corporations sink quickly into impoverishment when those corporations pull up stakes and move to cheaper locales or automate the profitable work.

Communities that foster small-scale entrepreneurship, local efforts to address local scarcities and paid useful work thrive in ways that contrast sharply with communities dependent on bread and circuses and global corporations.

The model of expecting global corporations and Big Government to solve the scarcity of paid work is broken. Paul Mason does an excellent job of explaining why in this article from mid-2015: The end of capitalism has begun: the rise of non-market production, of unownable information, of peer networks and unmanaged enterprises.

Isn't it obvious that we need a new system?

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The exodus at Fox News continued on Monday, when less than two weeks after Bill O’Reilly’s termination, co-president Bill Shine was also shown the door as New York Mag’s Gabriel Sherman first reported and was subsequently confirmed in a memo to network employees from Fox News Executive Chairman Rupert Murdoch. The move came as Shine was due back on Monday after two days out of the office for a pre-planned long weekend.

“Sadly, Bill Shine resigned today. I know Bill was liked and respected by everybody at Fox News,” writes Murdoch. Suzanne Scott will become president of programming, while Jay Wallace is president of news.

According to Hollywood Reporter, the Murdochs had recently quietly put out external feelers for a new head of Fox News and were known to be looking for a woman, which would send a clear message given the cloud of sexism the network has been under since last summer when Gretchen Carlson’s lawsuit opened the floodgates of similar accusations against Ailes as well as network star Bill O’Reilly.

In the press release announcing the executive shuffle, Rupert Murdoch said: “This is a significant day for all at FOX News. Bill has played a huge role in building FOX News to its present position as the nation’s biggest and most important cable channel in the history of the industry. His contribution to our channel and our country will resonate for many years.”

“Fox News continues to break both viewing and revenue records, for which I thank you all for. I am sure we can do even better,” Murdoch’s memo concludes.

New York Magazine’s Gabriel Sherman had first tweeted that Shine, who has been with the network since its inception, was no longer with the network “as of this morning.”

BREAKING: Two sources inside Fox News say Bill Shine is out as of this morning

— Gabriel Sherman (@gabrielsherman) May 1, 2017

Shine has been accused of covering up incidents of sexual harassment of Ailes, his former boss, who was ousted from the network last summer after Gretchen Carlson’s lawsuit against him. Since Ailes’ abrupt departure in summer 2016, he has served as co-president of Fox News Channel alongside Jack Abernethy — but his roots at the company are much deeper, as was his work with Bill O’Reilly.

Shine, who had been with FNC since its 1996 launch, has most famously been the top player in the cable network’s programming division. He first served as senior vice president, ultimately becoming senior executive vice president before his current expanded role. While in programming, Shine was the point person on the familiar, fiery conservative commentary that made its primetime a ratings winner. He was the executive in charge of O’Reilly, Sean Hannity and former staffer Greta Van Susteren.

Shine was also named in former Fox News personality Andrea Tantaros’ lawsuit against network executives, which claimed that Fox News “operated like a sex-fueled, Playboy Mansion-like cult.”

Sean Hannity, a friend and colleague of Shine’s, took to Twitter on April 27 to defend the network co-president, fearing the “end of the FNC as we know it” without Shine. Rupert Murdoch took Shine and Abernethy to lunch in Manhattan on April 24, for what appeared to be a very public show of support. But since then the pressure has only mounted on Shine; most recently, his name came up in a class action racial discrimination suit led by Fox News anchor Kelly Wright.

Shine’s departure is the fourth big exit to rock Fox News since last year including Megyn Kelly’s defection to NBC News where she’ll host a primetime newsmagazine and daytime program. 

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Authored by Lance Roberts via RealInvestmentAdvice.com,

Last week President Trump announced his “tax plan” which discussed lowering the corporate tax rate, closing tax loopholes, reducing individual income tax brackets and increasing standard deductions. That table below, via Goldman Sachs, shows the comparison between current law and the various proposals.

President Trump campaigned on lowering taxes as a means by which economic growth could be jump started, and with Q1’s economic growth coming in at a meager 0.7% annualized, it would certainly seem to be needed.

The issue of tax reform is not going to be an easy one. With such a deeply partisan government the probability of passing tax reform as currently proposed is extremely slim. Furthermore, while I do expect that some version of tax reform will eventually get passed, it will likely take much longer than most expect. The chart below shows the current chasm leading to the difficulty of getting anything accomplished in Washington.

But the question I want to address today is simply this:

“Do tax reductions lead to higher economic growth, employment and incomes over the long-term as promised?”

This is after all what is being promised. On Sunday morning, speaking to NBC’s Meet the Press, VP Mike Pence confirmed just that as he was confident that eventually, the deficit would decline as it would be overcome by economic “growth” thanks to the tax cuts it will fund.

Simple. Right?

Maybe not. The reason is that a tax-rate reduction is quickly absorbed into the economy. Let’s look at the following simple example:

• Year 1: GDP = $1 Trillion 
• Taxes Are Reduced Which Puts $100 Billion Into The Economy.
• Year 2: GDP = $1 Trillion + $100 Billion = $1.1 Trillion or 10% GDP Growth
• Going Into Year-3 There Are No New Tax Cuts And All Spending From Previous Year Remains
• Year 3: GDP = $1.1 Trillion + $0 = $1.1 Trillion or 0% GDP Growth

As shown in the chart below, changes to tax rates have a very limited impact on economic growth over the longer term.

Furthermore, it is believed that tax cuts will lead to a boom in employment. The chart below shows the corporate tax rate versus employment back to 1946. Corporate tax levels create employment change at the margin. If you look at the chart you will notice that when corporate tax rates are reduced employment did marginally increase but only for a short period of time.

What drives employment is sustainable economic growth that leads to higher wages, increased aggregate demand and higher rates of production. In other words, employment adjusts over time to respond to the strength and direction of the economy rather than the movements in tax rates. The chart below shows economic growth versus employment.

Do not misunderstand me. Tax rates CAN make a difference in the short run particularly when coming out of a recession as it frees up capital for productive investment at a time when recovering economic growth and pent-up demand require it.

However, in the long run, it is the direction and trend of economic growth that drives employment. The reason I say “direction and trend” is because, as you will see by the vertical blue dashed line, beginning in 1980, both the direction and trend of economic growth in the United States changed for the worse.

Furthermore, as I noted previously, Reagan’s tax cuts were timely due to the economic, fiscal, and valuation backdrop which is diametrically opposed to the situation today.

“Importantly, as has been stated, the proposed tax cut by President-elect Trump will be the largest since Ronald Reagan. However, in order to make valid assumptions on the potential impact of the tax cut on the economy, earnings and the markets, we need to review the differences between the Reagan and Trump eras. My colleague, Michael Lebowitz, recently penned the following on this exact issue.

 

‘Many investors are suddenly comparing Trump’s economic policy proposals to those of Ronald Reagan. For those that deem that bullish, we remind you that the economic environment and potential growth of 1982 was vastly different than it is today.  Consider the following table:'”

The differences between today’s economic and market environment could not be starker. The tailwinds provided by initial deregulation, consumer leveraging and declining interest rates and inflation provided huge tailwinds for corporate profitability growth. The chart below shows the ramp up in government debt since Reagan versus subsequent economic growth and tax rates.

(Important Note: The slight downtick in the Debt/GDP ratio is ONLY DUE to the debt ceiling being frozen currently at $20 Trillion. With the passage of a continuing resolution, new debt issuance will surge pushing the current ratio to new highs.)

Of course, as noted, rising debt levels is the real impediment to longer-term increases in economic growth. When 75% of your current Federal Budget goes to entitlements and debt service, there is little left over for the expansion of the economic growth.

The tailwinds enjoyed by Reagan are now headwinds for Trump. 

But it isn’t just the Government that has lost its way in terms of “fiscal responsibility.” As the next chart shows, as economic output declined – consumers also turned to debt to sustain their standard of living which reduced personal savings and productive investment. The Austrian Business Cycle Theory predicted that the current economic malaise would be caused by:

“…the inevitable consequence of excessive growth in bank credit, exacerbated by inherently damaging and ineffective central bank policies, which cause interest rates to remain too low for too long, resulting in excessive credit creation, speculative economic bubbles and lowered savings.”

In other words, the proponents of Austrian economics believe that a sustained period of low interest rates and excessive credit creation results in a volatile and unstable imbalance between saving and investment. Low interest rates tend to stimulate borrowing from the banking system which in turn leads, as one would expect, to the expansion of credit. This expansion of credit then, in turn, creates an expansion of the supply of money and, therefore, the credit-sourced boom becomes unsustainable as artificially stimulated borrowing seeks out diminishing investment opportunities. Finally, the credit-sourced boom results in widespread malinvestments.

Does any of this sound familiar?

As I discussed this past weekend, the rise in delinquency rates may be a warning sign that debt-driven malinvestments have likely come home to roost.

This is why the economic “boom” of the 80’s and 90’s was really not much more than a debt-driven illusion that has now come home to roost.  (More discussion on this problem here, here and here)

Tax Cuts Don’t Reduce The Deficit

So, back to Vice-President Pence’s belief that tax cuts will eventually become revenue neutral due to expanded economic growth, Peter Baker via the NYT recently made the same point:

“While a corporate tax rate cut of the dimension Mr. Trump envisions would reduce tax revenues by more than $2 trillion over the next 10 years, Mr. Mnuchin noted that an increase in economic growth of a little more than one percentage point would generate close to the same amount. The goal, he said, was to produce a sustained national growth rate of 3 percent, instead of the 1.8 percent now projected over the next decade.”

The problem with the claims is there is NO evidence that is the case. The increases in deficit spending to supplant weaker economic growth has been apparent with larger deficits leading to further weakness in economic growth. In fact, ever since Reagan first lowered taxes in the ’80’s both GDP growth and the deficit have only headed in one direction – lower.

As noted above, there are massive differences between the economic and debt related backdrops between the early 80’s and today.

The Committee For A Responsible Federal Budget just recently analyzed Trump’s proposed tax plan and came away with the following analysis:

“The White House released principles and a framework for tax reform today. We applaud the President’s focus on tax reform, but the plan includes far more detail on how the Administration would cut taxes than on how they would pay for those cuts. Based on what we know so far, the plan could cost $3 to $7 trillion over a decade– our base-case estimate is $5.5 trillion in revenue loss over a decade. Without adequate offsets, tax reform could drive up the federal debt, harming economic growth instead of boosting it.”

The true burden on taxpayers is government spending, because the debt requires future interest payments out of future taxes. As debt levels, and subsequently deficits, increase, economic growth is burdened by the diversion of revenue from productive investments into debt service. 

This is the same problem that many households in America face today. Many families are struggling to meet the service requirements of the debt they have accumulated over the last couple of decades with the income that is available to them. They can only increase that income marginally by taking on second jobs. However, the biggest ability to service the debt at home is to reduce spending in other areas.

While lowering corporate tax rates will certainly help businesses potentially increase their bottom line earnings, there is a high probability that it will not “trickle down” to middle-class America.

While I am certainly hopeful for meaningful changes in tax reform, deregulation and a move back towards a middle-right political agenda, from an investment standpoint there are many economic challenges that are not policy driven.

• Demographics
• Structural employment shifts
• Technological innovations
• Globalization
• Financialization 
• Global debt

These challenges will continue to weigh on economic growth, wages and standards of living into the foreseeable future.  As a result, incremental tax and policy changes will have a more muted effect on the economy as well.

As Mike concluded in his missive:

“As investors, we must understand the popular narrative and respect it as it is a formidable short-term force driving the market. That said, we also must understand whether there is logic and truth behind the narrative. In the late 1990’s, investors bought into the new economy narrative. By 2002, the market reminded them that the narrative was born of greed not reality. Similarly, in the early to mid-2000’s real estate investors were lead to believe that real-estate prices never decline.

 

The bottom line is that one should respect the narrative and its ability to propel the market higher.“

Will “Trumponomics” change the course of the U.S. economy? I certainly hope so. Unfortunately, there is no evidence that such has ever been the case.

As investors, we must understand the difference between a “narrative-driven” advance and one driven by strengthening fundamentals. The first is short-term and leads to bad outcomes. The other isn’t, and doesn’t.

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